Pop goes the emerging-market bubble

Tuesday

Sep 3, 2013 at 2:38 PMSep 3, 2013 at 2:44 PM

Robert J. Samuelson - Economic Commentary

Could we be on the cusp of the next economic crisis? Just in case you hadn't noticed, the latest warnings come from Brazil and India, whose currencies are under attack. If the assaults spread to most "emerging-market" and developing countries, which represent about half the world economy, the effect on the fragile global recovery could be devastating. That's the bad news; the good news is that -- for the moment -- this is widely regarded as a long shot.

First, let's get our bearings.

Brazil represents almost 3 percent of the world economy, India nearly 6 percent, estimates the International Monetary Fund (IMF). In recent months, investors have withdrawn local bank deposits and dumped local stocks and bonds. They sell their proceeds in Brazilian reals and Indian rupees for other currencies -- presumably, mostly dollars -- and shift the funds elsewhere. Selling the currencies lowers their value. Panic selling in these and other countries would further depress local stock prices, confidence and spending. Already, Brazil's stock market is off about 20 percent this year, India's about 8 percent.

These money outflows partially reverse the inflows of 2010 and 2011, when emerging-market countries attracted more than $1 trillion from global investors, according to IMF figures. "The interest rate differentials were huge," says Peterson Institute economist Arvind Subramanian. "In the United States, you were getting 1 percent to 2 percent. India offered 9 percent to 10 percent on rupee deposits."

For a while, global investors were infatuated with emerging markets. There was a sense that "developed markets [the United States, Europe] were risky and that emerging markets were risk-free," says Angel Ubide, also of the Peterson Institute. Emerging-market countries would grow faster; they had embraced sensible economic policies of low inflation and manageable budget deficits. Many would benefit from the relentless rise in global demand for raw materials. Brazil seemed especially blessed, being a major supplier of soybeans, sugar, iron ore and coffee. Emerging-market countries seemed the logical destination for investors seeking higher returns.

No more. To the extent there was an emerging-market "bubble," it has popped. Yesterday's conventional wisdom is not today's. Economic policies turned out to be not so sensible -- or sustainable. India's inflation is running about 10 percent, and its budget deficit is about 8 percent of the economy (gross domestic product). Contrary to widespread expectations, commodity prices have not inexorably climbed. Economic growth has disappointed. In 2012, Brazil's GDP grew only 0.9 percent, down from 2.7 percent in 2011 and 7.5 percent in 2010. The China story is similar: Growth has slowed, policies seem less sound.

Global investors' reappraisal was apparently triggered by the possibility that the Federal Reserve would reduce its $85 billion of monthly bond purchases. This would mean less money to prop up stock prices around the world, including in emerging markets. Brazilian officials and some others complain that Fed policy whipsaws them: first, an inrush of money fosters easy credit and higher stock prices; then, an exit of funds does the opposite. Fed actions inevitably cause investors to re-evaluate their portfolios, says Ubide. He also rates Turkey and South Africa as vulnerable to shifting investor sentiment.

Still, Ubide and many economists doubt a doomsday outcome. "There is no serious risk of a major global crisis," says Subramanian. That could happen if uncontrolled sell-offs around that world exhausted countries' foreign-exchange reserves (mostly dollars) that ultimately enable them to import. Global trade and production would plummet. By contrast, says Subramanian, today's market turmoil reflects an unavoidable adjustment to more normal Fed policy. In a report to clients, Capital Economics, a consulting firm, says emerging-market countries have defenses against a broader crisis: high foreign-exchange reserves; low foreign-currency debts; more flexible currencies.

All this sounds reassuring -- and probably is. But nagging doubts remain. Every major financial crisis of the past 20 years has begun with some relatively minor event whose significance seemed isolated: weakness of the Thai baht in the summer of 1997; trouble in the market for "subprime" U.S. mortgages in 2007; Greece's misreporting of its budget deficit in 2009. Could this be "deja vu all over again"?

Robert Samuelson is a columnist for the Washington Post Writers Group.